Being able to restructure mortgages always struck me as being the most reasonable way to deal with the foreclosure crisis. This is especially true now that Chapter 7 is no longer a possibility for most people. It has other advantages besides stopping foreclosure: it punishes the bad actors and it doesn't cost the government a load of dough. Plus there is no moral hazard associated with it as there is with other bailout schemes which have been discussed. It is well past time to make this change in the bankruptcy laws.

It would seem more than reasonable to treat people better than companies in the country founded for We, the People.

There is no reason why such a reasonable accomodation such as this should not become law. The terms could even include some recapture of reduced loan principle (up to the amount the principle was reduced by the bankruptcy court) if the value of the home shoots up once again within some reasonable period of time. And it's not just corporations who get the breaks--those individuals who happen to have mortgaged vacation homes are able to restructure those loans in bankruptcy court. To not allow such a restructuring makes absolutely no sense.

I think one key component missing is the institutions' greed. These huge banking institutions are asking for millions of dollars to keep them afloat, yet they fail to start by cutting their losses with small homeowners. They are starting from the top, setting aside money for golden parachutes and year-end bonuses, before utilizing the money to create flowing credit.

It's just like the Detroit 3. Execs want to keep their personal finances afloat before they even consider the generic American economy. They are just stealing the American people's hard earned money.

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Bailout Bums: Stealing YOUR Money: http://tv1.com/playlists/80

Of course, if the mortgages were actually reduced it probably wouldn't look so good for the incompetent who set it up in the first place, now would it? Can't have that.

Doug, my understanding is the people who set up these mortgages were not incompetent, but criminal. I saw an expert on finance.yahoo say that a high percentage (50%) of the mortgages were criminal fraud. I don't see anyone doing any perp walks.

Hey, hold on a mo, bro. Next thing you'll suggest is for Reagan's Welfare Queens to get their Caddilac payments reduced to reflect the depreciated value of the car. . .

Ah yes, one of the "benefits" of big-money corporate money in US politics.

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One of the things I've heard from financial firms is that the sanctity of the contract should not be destroyed by allowing a judge to refinance a mortgage. If that's true, and if Congress doesn't want judges to handle mortgage refinancing, then the court shouldn't be allowed to handle any requests from financial firms to refinance to help them.

How did courts get involved in redoing mortgages anyway? They should enforce the law, not get involved in financial transactions.

One of the things I've heard from financial firms is that the sanctity of the contract should not be destroyed by allowing a judge to refinance a mortgage

Bankruptcy modifies contracts all the time. Just for businesses.

I hear that there is a problem because the mortgages have been sliced and dices so much, that a responsible party can't be found to negotiate with. Of course this is where you would expect government to step in. Wouldn't that be a better usage of public money, than simply shoveling cash at insolvent banks?

Now I can see a couple of issues that make this nonideal. First there still exists moral hazard. I can buy a house on credit, and get the bank to take on much of the downside price risk. But, the same issue arises with business lending. A secondary issue, is that the value per loan transaction is pretty small, so the amount of resources that can reasonably be spent per renegotiated loan has to be carefully controlled. Also we don't want to repeatedly renegotiate the same loan every time the housing market rackets down.

But, these problems ought be manageable. What seems to be lacking is the will, not the way.

I think it's a good idea to allow mortgages to be restructured. However, don't ignore a major side effect of changing it. Mortgage rates are going to go up as the chance of restructuring is priced in.

One of the things I've heard from financial firms is that the sanctity of the contract should not be destroyed by allowing a judge to refinance a mortgage.

The idea that contracts are "sacrosanct" is wishful thinking. Rights under a contract are not property. It's just a device to bridge the gap between a promise and its performance, and its sole purpose is to promote efficient exchange. If a contractual exchange is no longer efficient, courts can ordinarily intervene -- even outside of bankruptcy. It's not something a judge would do lightly, but it's certainly one of the options available. This statutory restriction on modifying mortgage terms is a very special exception.

The average household is simply too small to waste time preventing its economic collapse.

Only the rich and powerful count in this society.

I hear that there is a problem because the mortgages have been sliced and dices so much, that a responsible party can't be found to negotiate with. Of course this is where you would expect government to step in. Wouldn't that be a better usage of public money, than simply shoveling cash at insolvent banks?

Now I can see a couple of issues that make this nonideal. First there still exists moral hazard. I can buy a house on credit, and get the bank to take on much of the downside price risk. But, the same issue arises with business lending. A secondary issue, is that the value per loan transaction is pretty small, so the amount of resources that can reasonably be spent per renegotiated loan has to be carefully controlled. Also we don't want to repeatedly renegotiate the same loan every time the housing market rackets down.

But, these problems ought be manageable. What seems to be lacking is the will, not the way.

"Persuaded Congress..." But of course it isn't primarily an exercise in logical proof. Let's say, "per$uaded" ....

BTW the excuses that dividing up the mortgage impedes renegotiation: Well, maybe it makes it harder to know who to renego with, but if the Court decides what to do, you just change the conditions of payment to whoever you were giving the money to, and they just have to deal with it from there.

This is precisely what happens when the concerns of corporations are allowed to take precedence over the concerns of individual citizens.

The scary part is that this is far from an isolated example. We saw it with the modification of bankruptcy laws a few years ago, we see in the anti-tort movement, we see it with health insurance companies who try to exclude anyone with pre-existing conditions, and regular insurance companies who try to weasel out of their obligations when people actually make a claim, as happened after hurricane Katrina.

For every deserving homeowner needing mortgage reamortization - by that I mean those that did not treat their homes as an ATM machine on the way up, or did not lie about income - there are 15 former college or trade school students that deserve relief from the student loans they were sold by the educational-industrial complex. I do counseling for social service programs and cannot exagerate the unequitable nature of these programs... unfortunately acedemics that make money charging for the pearls of wisdom falling from their lips are mostly on the left, so their victims are not very likely to be treated as well as more photogenic victims of capitalists.

I hear that there is a problem because the mortgages have been sliced and dices so much, that a responsible party can't be found to negotiate with

It's worse than that. Different people own different parts of the mortgage, and that allocation is based on risk assumed by the buyer of the piece. So the guy who bought the safest piece is getting 70 or 80 cents on the dollar (remember, this borrower has already paid a good chunk of money toward the loan), while the guy who bought the toxic waste hasn't gotten anything. But they paid for their tranches based on their assumption of risk. It's a dealbreaker for the guy who bought the safer bet to be told that he actually bought something else.

He'll sue. He'll win.

I'm spacing the name of the guy who had been sending letters to the Fed telling them this would happen--that the people who bought the safer tranches would never be brought round. But it makes sense.

Damn good thing Joe Biden is not going to be in the Senate after January 20. He would do everything he could to torpedo any bankruptcy reform that might actually help solve the problem.

If the court found that the market value of her home had fallen below what she owed, the secured portion that must be repaid in full would be reduced to the house's actual value; otherwise, the amount to be repaid would stay the same.

I wonder if the bank could demand a symmetry: if the market value increases, then the balance on the loan increases as well. Some homeowners do this with home equity lines of credit, and sometimes banks encourage that; but it isn't required.

A question: would such a revision as proposed permit banks to cut their risks by re-establishing stricter lending standards than what they have recently had forced upon them?

When banks lose money, it's their depositors who lose the money, not just the banks. This makes the proposal like the tax-supported bailouts

Lastly, the advantages of the foreclosure are that it cuts the administrative cost and reduces the uncertainty of future loss. These considerations matter a lot to the people actually carrying on the businesses.

thank you, Hilzoy, for a good post.

Bankruptcy Court is supposed to be the one court of equity in the US. Of course, the credit card companies bought an exception to this principle that recreated the debtor's prisons from Europe.

I believe that Judge Leonard is on the right track. The Bankruptcy judge should have more authority to place the bankrupt back in commerce. That is what free enterprise is all about.

Perhaps then the emphasis in Bankruptcy court can return to the bankrupt and the creditors. For too long the winners have been the attorneys in that arena. The rules stop the bankruptcy trustees from unjust enrichment at the expense of their bankrupts and the creditors. There are no such rules protecting the creditors and the bankrupt from the attorneys -- who are often bankruptcy trustees themselves in other cases.

The Quid Pro Quo is in plain view, yet no one seems willing to ask the obvious questions of the big pink elephant in the court room?

Would a rule that no bankruptcy trustee be allowed to practice in bankruptcy court be that unreasonable considering the potential conflict of interests? Such a rule would suddenly have all attorney fees and costs more accountable and creditors and bankrupts would be the obvious winners.

Marketeer,

It is certainly possible to allow a bank to recapture some of the forgone principle if the homeowner makes a profit on the sale of the house. This is what Sheila Baer at the FDIC has been doing on the mortages which she is renegotiating at IndyMac. I don't see anything wrong with that.

I also do not see anything in a revision of the bankruptcy laws which would prevent banks from imposing stricter lending standards. The two issues are orthagonal. In addition the idea of the cramdown (as this is called) is that banks can keep a performing loan in their protfolio rather than going through the rather expensive process of foreclosure. This helps everyone, although the bank will not make as much profit on the resulting restructured loan, keeping loans performing will help quite a bit.

For those of you who worry about moral hazard, bankruptcy is no picnic. It puts a black mark on your credit for 7 years. If you go chapter 13, you will have large amounts of money yanked out of your paycheck for 5 years, forcing you into a frugal lifestyle. You will not be able to get reasonable amounts of credit for a long time, nor will you have the money to build any sorts of savings. If you get a tax refund it goes to the receiver. You are basically financially screwed for 5 years. Where is the moral hazard in that?

As I said in my previous post, this proposal puts the bad actors at risk; this is only proper. People who sold toxic mortgages should take a haircut. Doing this will certainly cut the market for subprime and Alt-A mortgages, but these are people who should never have bought a house in the first place, especially at the inflated prices seen in the 2005 - 2006 period. The entire business was based on the assumption that home prices would climb forever. Here in Bozeman, I saw home prices nearly double in 5 years and I really didn't understand how people could afford them, but the answer was option ARMs. Most of my friends were lucky enough to refi into fixed mortgages after a couple of years because prices here have not fallen as fast as in other parts of the country. They are now -- prices are crashing and new home building has basically stopped. Stuff is going to get ugly here in a few months.

Hilzoy, thank you for pointing this out. How could we all have missed this for so long. Or, more personally, how did I miss this perfectly obvious point. It's the perfect legal answer to all the bullshit that snowed out the true perspective.

Be nice if they did credit cards, too.

And to even the field in bankruptcy, not just mortgage negotiation.

The law should be equal, and lobbyists have done too much damage.

restructuring would have allowed almost all of this problem to go away in fairly short order: All those "bad" loans would have become "good" loans. That is the bottom line.

I was asking this question on day one.

But the loans did not ever have to be re-structured, per se. All the lenders had to do was offer DOABLE re-finances for the bad loans. It ends up being the same thing, and does not require laws to be re-written.

Every lender had this option available to them - re-financing into workable loans - but none of them opted for it. There were MONTHS between recognition (late 2007) of the problem and the melt-down, during which all of them could have done all kinds of things to re-make those loans into good loans. Why didn't they? They had time to reclassify the packages (and portions of packages) of loans that were bought and sold into three levels of quality, and they all had time to look at all the loans and classify, but not to actually DO something about it all? Hard to believe.

Now, failing that choice, the NEXT best thing would have been to funnel the $700B (or whatever the real number is) TO the borrowers - and it did not have to be the entire value of the mortgage, only the amount that would make the payments doable by the borrower. It would become, essentially, a subsidized loan. And when that money then flowed THROUGH them, it would have ended up in the hands of the lenders. In this manner, BOTH parties are helped. The lenders get the same amount of money, and the borrowers are saved from foreclosure or bankruptcy.

The current "plan" gives the money to the lenders directly, bypassing the borrowers, leaving them out in the cold - and the lenders then own massively devalued properties they don't want to own. The borrowers are out on the street, with their credit damaged for the rest of their lives.

WTF? Who came up with that plan? And why did they latch onto THAT one, instead of something more constructive? Hand out a bunch of money to the lenders and leave a large portion of the borrowing public as paupers? Why would they decide on that action? Why were the borrowers never IN the equation?

These questions need to be asked.

And, obviously, the systems both need to be fixed - the old existing system, and the new bailout system, as well. Both of them totally suck.

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The judge is 100% wrong. The bankruptcy laws prohibit judges from modifying home mortgages in order to encourage lenders to make home loans. The result is lower interest rates, wider availability of credit, etc. Where the judge misses the boat, and the fact about which most of you seem to be utterly ignorant, is that home mortgages are not the only type of finance that the law encourages through this kind of protection from bankruptcy.

The bankruptcy laws do the same thing for mortgages of commercial aircraft and railcars. When United Airlines went bankrupt, it had 60 days either to resume payments on its mortgaged aircraft or to hand them over to the banks. The bankruptcy court had no, as in zero, power to modify the terms of those mortgages. Again, the purpose of this rule was to encourage lenders to loan money to airlines to buy aircraft.

Now you may think that encouraging lending in the future is less important than protecting current homeowners who are in financial trouble. That's a policy question on which reasonable people can differ. But it doesn't advance the policy discussion to assert falsely that home mortgages are the only type of secured finance that have a favorable position under the bankruptcy laws.

The bankrputcy law, rewritten largely to benefit the credit card and consumer loan industries, is the ugliest vestige of the predatory capitalist system built up over the past 20 years.

When it's taken down, credit will be tighter. Good. Macro- and micro-, credit that was too easy to get and too hard to erase got us into this mess.